Why Going Local Will Save Banking

I hope you’re not a National Australia Bank Ltd [ASX:NAB] customer.

If you are, your rates just went up.

NAB has hiked rates just a week before the royal commission released their recommendations.

The Morrison government believes NAB should explain their decision. The opposition said the timing of the lift was opportunistic and cynical.

I believe NAB, like any other for-profit business, should be able to do whatever they want. As long as it’s legal, go ahead.

But I thought they — along with the other Big Four — wanted to rebuild trust?

Is lifting rates so soon after sustaining such horrible press going to rebuild that trust?

Reported by the Australian Financial Review:

NAB raised the standard variable rate by between 12 and 16 basis points, ending a pledge made by chief executive Andrew Thorburn in September to keep rates on hold as part of a strategy to rebuild trust with its customers after a series of questionable practices were exposed by the Hayne commission.

But I guess it doesn’t matter.

Other than the Big Four, where else are you going to go?

The banks lie to cheat and steal from their customers.

And we’re expected to put up with it.

Not for long. This is how we could fix the system…

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Big banks like big clients

If you remember Friday last week, I wrote about WeBank and their push into Oz.

For those of you who don’t know, WeBank is an online bank. They’re a part of the WeChat app ecosystem.

People like to call WeChat the Facebook, Inc. [NASDAQ:FB] of China. But that’s not entirely accurate.

Yes, WeChat’s foundation is a social network. But from that platform WeChat has evolved into the only app you’ll ever need.

WeChat has payments applications, online shopping, ride-sharing, search functions. You can even book doctor appointments on the app, apply for travel visas, play games and get loans.

The idea of the article was to explain why I thought WeBank had no chance to make any real dint on the Australian banking sector.

The Big Four are just too large. They hold too much of the market and it makes things extremely tough for small lenders.

This isn’t just a problem in Australia either. In the US, countries within the European Union and the UK all have very concentrated banking systems.

And it’s this concentration that leads to terrible outcomes for little guys like you and me.

Economist Richard Werner talked about the problems in the UK banking sector back in 2011. He said in an interview with The Free Lunch – Fairness with Freedom:

When we look at the UK banking system we notice that about 90% of deposits, 90% of the banking market is accounted for by five banks.

We have a highly concentrated banking system. These are the five main high street banks. The trouble is when you have so few very, very large banks…they want to deal with large customers.

That means UK small firms are not very high on their list. In fact, they’re more or less a hassle because the cost in terms of doing due diligence and credit analysis on a small firm that wants a £20,000 loan is about the same as for a large firm that wants £200 million loan.

So, if you focus only on the big projects you’re neglecting something in the economy. The economy will become much more centralised. The big banks deal mainly with the big firms. The local economy, regional growth will be neglected.

Small firms and start-up firms have a very hard time getting funding.

If we look at Australian banking, we see the same kind of concentration for home loans.

The Big Four holds around 80% of Aussie home loans.


MoneyMorning 07-11-18

Source: the Guardian

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The major banks also hold just under 80% of their entire Aussie loan market too…


MoneyMorning 07-11-18

Source: RBA

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OK, you say. Then shouldn’t there be a huge market for smaller banks to come and service these smaller clients? Can’t they just chip away at the Big Four?

How to fix banking…

Under normal circumstances they could. But the Australian banking industry isn’t a level playing field.

The Big Four don’t just have scale on their side, they’ve got the help of regulators. The ABC wrote in 2016:

The big four banks enjoy a $19 billion advantage over their smaller rivals by still being able to self-calculate the riskiness of their home loans according to analysis from the Australian Prudential Regulation Authority.

Despite a new regulatory framework requiring the big banks to hold larger top tier capital buffers, their ability to internally assess their asset risks is still a huge advantage in terms of the amount of “expensive” capital locked up and their ability to access cheaper funding.

The average capital risk weights for a standard bank is around 39% down under. For the Big Four, it’s about 25%.

That means the Big Four can lend out far more cash and take on much more risk than most other banks.

The Big Four also have the comfort of knowing a bailout is always there when they need it. The Australian Banking Association explains:

One of the reasons being suggested for a new levy on Australia’s five largest banks is that it is compensation for the Federal Government’s implicit guarantee.

The rationale is that these banks are so important to the domestic financial system that their failure would cause significant disruption, and therefore in a crisis the Government would provide financial support to prevent these banks collapsing.

It’s a privilege that not all banks get, especially the smaller ones.

What we really need to fix our banking system is far smaller banks and less regulatory help for the Big Four.

With lots of small local banks, local economies can thrive. Small businesses get funding. Borrowers are less likely to default on their loans because they know the local bank manager personally.

Smaller banks also take on less risk, as their goal is to service their local borrowers and depositors.

Will we ever get to this localised banking world? I hope so. But it first has to start with regulators. As long as they continue to help the Big Four with unfair rulings, smaller local banks can’t make inroads.

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: Four-Step Guide to Small-Cap Success. Download your free report now.


Harje Ronngard is the lead Editor at Money Morning. He’s also the Editor of Wealth Eruption and co-Editor of the Third Wave Portfolio.

The aim of both Wealth Eruption and the Third Wave Portfolio is to find misunderstood opportunities. These are the type of investments that multiply small amounts of money five- to 10-times in size.

Harje has an academic background in investments and valuation. He’s had experience across a range of asset classes, from futures to equities.

For any investment, Harje believes you only need to ask two questions. What is it worth? And how much does it cost? These two questions alone open up a world of opportunities, which Harje shares with Money Morning readers five days a week.


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